Trust structures are regularly used for asset protection purposes as well as tax planning. Spouses who are separated and looking to resolve their property settlement, often presume that any assets held in a trust, will not be included in a property settlement claim.
This is not always the case particularly in a situation where one or both of the spouses has a controlling interest in the trust. Despite intentions to protect assets, sometimes the assets and income of a trust can be at risk when there is a claim for property settlement and/or spousal maintenance.
This article explores how trusts must be disclosed and how they may be treated in the property settlement process.
Trusts and the property settlement process
When to disclose an interest in a trust?
When a couple separates, one of the first steps is for each spouse to set out for the other what assets, liabilities and financial resources that they have an interest in (including assets, liabilities and/or financial resource that are held in their sole name, their joint names, or in joint names with other third parties) – this is called the asset pool . As part of that process, parties are required to provide the other with information and documents to verify the nature and extent of the assets, liabilities and financial resources that each party holds. This is often referred to as the process of disclosure.
As part of this disclosure process, if either spouse is a beneficiary of a trust, they are required to provide copies of all documents to confirm their interest. Such documents include:
- The deed that established the trust (including any variations of the deed);
- Copies of the financial statements and tax returns for the trust for the 3 financial years prior to separation (noting that the requirement to provide these documents will depend on the nature of the spouse’s interest as a beneficiary of the trust and whether the spouse has any control over the trust).
Will a trust be included in the pool of assets subject to a property settlement claim or will it be considered a financial resource available to one of the parties?
Generally speaking, if one spouse has control over a trust, it is more likely to be considered an asset that will be the subject of division as part of a property settlement claim.
There are essentially two different ways a trust can be treated in a property settlement. Depending on the circumstances and who controls the trust, it will either be considered:
- An asset; or
- A financial resource.
If the trust is considered an asset of the relationship, it will be included in the pool of assets to be divided between the spouse parties of the relationship as part of their property settlement. Depending on how and when the trust was established, and the level of control one spouse has over that trust, the spouse who has an interest in the trust may receive some ‘credit’ for having that trust included in the asset pool. This means if the trust and its assets were established because of the efforts and means of one spouse alone, then that spouse may receive a higher property settlement entitlement because they contributed the trust and its assets to the asset pool. It is important to note however, that to receive ‘credit’ for contributing an asset in the asset pool does not necessarily mean that the asset will be ‘credited’ to that spouse at the exact dollar amount at which it was included initially.
If the trust is a financial resource of one of the spouses:
- it will not be included in the pool of assets; but
- will be considered as something that is available to one of the spouses at the time and is likely to continue to be available to that spouse in the future.
For example, if one party has and is likely to continue to have access to an income stream from a trust going forward, then the other spouse may receive an adjustment of the asset pool in their favour. For example, the spouse who doesn’t have access to the trust income going forward may receive ‘compensation’ by way of an adjustment to their property settlement entitlement to take into account the fact they won’t have access to the financial resource. Again, this adjustment or ‘compensation’ will not be made on a ‘dollar for dollar’ basis in terms of the financial resource available to one spouse and not to the other going forward.
Who has control of the trust?
The main factor the Court will look at to decide if a trust is an asset of a relationship is whether one or both spouses has a controlling interest in that trust. To determine that, generally your family lawyer will work out who controls and owns the trust by looking at the trust deed. The deed will usually reveal:
- Who the trustee is – is it one or both of the parties or is it a company of which both or one of the parties is a director and/or shareholder?;
- Who the appointor or principal of the trust is – because that is the person who can remove the trustee and replace them with a new one at their election;
- Who the beneficiaries of the trust are – is it one or both of the spouses or a spouse and their siblings or extended family?
Your lawyer will also need to consider:
- How are the assets and income of the trust being treated by reviewing the spouses personal tax return and if available, the financial statements of the trust? For example, has either spouse been:
– receiving income distributions on a regular basis or drawing funds from the trust by way of loan over a period of time; or
– using the assets of the trust for personal use. For example, have they borrowed against them or do they live in or spend time in a property owned by the trust?
In some cases a trust, on the face of the deed, appears to be owned and controlled by a third party. That is, another person or company is the trustee and/or the appointor. Sometimes that third party is someone who has a connection or personal/family relationship with one of the spouses (e.g. a parent of one spouse, an accountant or other advisor of one of the spouse parties). In those situations, the other spouse may argue that the trust is actually an asset of the relationship because for example, that person has received income or used assets of the trust as if they belonged to him/her personally. In order to demonstrate that a spouse is in control of and owns a trust, the other spouse needs to prove the third party (who on paper appears to own and control the trust), is in fact the ‘puppet’ of one of the spouses and the spouse the ‘puppet master’, so to speak. This means you need to prove that the person who appears to control the trust actually takes action on the trust at the direction of one of the spouse parties.
If the trust is considered an asset – who retains it?
If a trust is deemed an asset and included in the asset pool, next comes the question ‘Which spouse will keep the trust?’ This all depends on the structure of the asset pool and what other assets are available to meet the entitlement of each of the spouse parties. For example, if there are insufficient assets outside of the trust to meet a spouse party’s entitlement, there may need to be a transfer of an asset or payment of cash from a trust to that spouse (or to another entity to be retained by that spouse). If that is the case, it is imperative that both spouse parties obtain accounting advice to ascertain the tax consequences of transferring assets out of a trust or paying distributions. In cases where the asset pool is made up of many large and complex corporate and trust structures, the tax implications of achieving a settlement may be very significant which will in turn diminish the value of the asset pool.
Often to mitigate this, a spouse that is not retaining the trust structure will agree to receive their property settlement over a period of time, perhaps with an interest component or at a higher payment amount overall to ‘compensate’ them for waiting for their settlement. In doing so, security and default provisions in the agreement are vital in case the payments do not eventuate.
A few things to keep in mind
If you are considering separating from your spouse and one or both of you has an interest in a trust, there are a few things for you to keep in mind as part of the settlement process.
If you are the spouse who is a beneficiary of a trust that is controlled by other family members, you need to very carefully consider how you deal with the income and assets of that trust during the relationship. This is because the trust in this circumstance may be included as an asset of the relationship, and that might not align with the original intention of the trust when it was set up.
Then on the other side, if you are the spouse who has limited awareness or control about your spouses’ interest in a trust, then you need to obtain all the source documents relating to that trust as soon as possible after separation. This is important so you can ascertain the nature and extent of your spouse’s interest in that trust and obtain accounting and legal advice about it.
It is really important you have up front all the documentation so you know what is involved when you are negotiating a property settlement. This is because if a large portion of your assets are held within these kinds of structures, you are going to have to work out how to extract some of the cash and assets, whether that’s straight away or over time.
It is for this reason that if you are looking to separate and you know you have complex financial structures involved, including trusts, you should speak to a family lawyer who is highly experienced in this area and can seek to request this information as part of that financial disclosure process. They can give you an understanding of what happens in the family law context. Additionally, we recommend that you speak to your financial advisor to determine what would be in your best interests, given any potential tax consequences.
Phillips Family Law is an award winning Family Law practice serving clients across Australia and abroad. We regularly assist clients with complex property settlement matters. Regardless of where you are in your decision making process, we can make you aware of your options. To discuss your situation confidentially phone +61730079898 or secure a time by clicking here.